Helm. > Australian Real Estate. market timing. Investment Trusts (A-REITs) OCTOBER FEATURE ARTICLE Estate planning for your super

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1 Helm OCTOBER 2012 FEATURE ARTICLE Estate planning for your super PLUS > The perils of market timing > Australian Real Estate Investment Trusts (A-REITs)

2 Helm - October 2012 Estate planning for your super By Michael Laurence What will happen to my superannuation savings and to my self-managed super fund in the event of my death? This is a fundamental question that astute super fund members are asking themselves and their advisers. Asking such questions is particularly critical given the sheer size of Australia s superannuation savings and the rapid ageing of our population. Just consider the huge volume of babyboomers nearing or entering retirement. Here are a few facts that truly underline the importance of sound estate planning for your super. Statistics from the Australian Prudential Regulation Authority show that superannuation savings exceed $1.4 trillion dollars and that the average self-managed super fund (SMSF) holds almost $920,000. The ageing of our population is reflected in the makeup of our super savings. For instance, the latest Vanguard/Investment Trends Self Managed Super Fund: Investor Report, published earlier this year, found that a third of SMSF members are already in retirement while another 34 per cent plan to retire within 10 years. And the most recent Superannuation Market Projections report, published by Rice Warner Actuaries, highlights that SMSFs hold more than half of the superannuation dollars invested in retirement products (which include transition-toretirement pensions.) As part of their estate planning for super, fund members should understand who can legally receive their super death benefits and how different beneficiaries may be taxed differently on those benefits. Further, don t overlook the practical challenges facing your family regarding the future of your SMSF after your death. Super misconceptions It is worthwhile immediately addressing common misconceptions about your super benefits and your will. Daniel Butler, managing director of DBA Lawyers, emphasises that super death benefits do not automatically form part of a deceased estate despite widespread views to the contrary. This is because superannuation savings are not personally owned but are held in trust by a super fund. (Butler s firm publishes The complete guide to SMSFs and planning for loss of capacity and death.) Unless you make a valid binding death benefit nomination specifying how your super will be distributed among eligible dependants, your super fund s trustees have full discretion about which of these dependants will receive your super benefits. Alternatively, the trustees may choose to pay the benefits to your estate. And the only way that a will can direct how super death benefits are distributed is for the amounts to be paid first to the deceased personal legal representative (deceased estate). Who can receive my super benefits? Superannuation death benefits are generally only payable to deceased members dependants, as defined in superannuation law, or to their estate. Eligible superannuation dependants are the deceased s spouse (including a de facto), children of any age, financial dependants and a person who had an interdependency relationship with the deceased. (An interdependency relationship can include having a close personal relationship, living together, or providing domestic or financial support by either person.) Can I nominate who will receive my benefits? The trust deeds of super funds allow members to make non-binding nominations stating who among their eligible superannuation dependants they would prefer to receive their super death benefits. Alternatively, fund members can make a nomination in favour of their estate. Fund trustees have the discretion to override non-binding nominations and decide which eligible superannuation dependants or the deceased s estate will receive the benefits. However, the trust deeds of many large super funds and most self-managed funds permit members to make binding death benefit nominations specifying which of their eligible superannuation dependants or their deceased estate will receive their benefits. Significantly, binding nominations override the trustees discretion. 2 Connect with Vanguard > vanguard.com.au >

3 Helm - October 2012 was over 60 at the time of death. Otherwise, the taxable component is taxed at the tax dependant s marginal tax rates less a 15 per cent tax offset. Fund members may decide, for instance, to make binding nominations in favour of individuals who are considered best able to cope with large amounts or who will receive the most favourable tax treatment. Butler says that one of the risks with binding nominations is that members may forget to change their nominations if their circumstances or relationships change. Another risk is that the binding nomination may expire without a fund member taking action to renew it. (With large funds and many SMSFs, binding nominations expire after three years.) How will my beneficiaries be taxed? A key part of estate planning for super is to understand how different beneficiaries may be taxed differently on your superannuation death benefits. The taxable component of a lump sum death benefit is taxed at 16.5 per cent unless received by the deceased s spouse, former spouse, children under 18, financial dependants and those who had an interdependency relationship with the deceased. (These are sometimes known collectively as tax dependants.) Butler explains that if a fund ever claimed a tax deduction for a life insurance premium in respect of the deceased member, a proportion of a lump sum death benefit paid to a non-tax dependant such as an independent adult child is taxed at 31.5 per cent. This higher tax applies whether or not the benefit includes an insurance payout. The taxable component of a super death benefit includes salary-sacrificed and compulsory contributions as well as fund earnings. Financial planners and other superannuation specialists often advise their clients about legitimate strategies to reduce the taxable component of their clients superannuation savings and therefore the tax payable by their adult children on inherited super. A reversionary superannuation pension paid to a tax dependant typically the deceased s spouse is tax-free if the deceased was over 60 or the reversionary pensioner What happens to my SMSF after my death? Superannuation benefits cannot be left indefinitely in your SMSF even if the beneficiary is your surviving spouse and a member of the same fund. The amount must be paid out as a lump sum or continue to be paid as a reversionary pension. A common challenge for SMSFs arises if the most active member dies first. This can lead to difficulties for surviving members/trustees and other family members, unless adequate planning has been undertaken. Butler says that estate planning strategies to consider for an SMSF include: Nominating a successor trustee if the fund has individual directors or a successor director if the fund has a corporate trustee. Bringing adult children into their parents SMSF as members while both parents are still alive if appropriate given family relationships, including the degree of trust and the interests of other children. (All members of an SMSF must be individual trustees or directors of the fund s corporate trustee.) Having a corporate trustee rather than individual trustees. A trustee director can be more readily replaced in the event of death or serious illness. Corporate trustees continue to hold a fund s assets regardless of a change of directors. An SMSF left with a surviving individual trustee following the death of a member must appoint another individual trustee or a corporate trustee (which can have a single director) within six months of the death benefit commencing to be paid. The deceased s legal personal representative (estate) can be appointed as a temporary individual trustee (or as a trustee director if the fund has a corporate trustee). It can be a valuable and thoughtful legacy to leave behind a well-organised SMSF where members have undertaken careful estate planning. References include: The complete guide to SMSFs and planning for loss of capacity and death, published by DBA Lawyers. Australian Superannuation Handbook, edited by Stuart Jones, published by Thomson Reuters. The Vanguard/Investment Trends Self Managed Super Fund: Investor Report. The Superannuation Market Projections report, published by Rice Warner Actuaries. 3

4 Helm - October 2012 The perils of market timing Investment a science or an art form? This question may long be debated but we believe the investment decision should be based on a methodical review of the risk and rewards of the investment strategy. Market timing may be considered art rather than science however research has shown that asset allocation decisions based on market timing are less likely to be successful. Strategic Asset Allocation (SAA) versus Tactical Asset Allocation (TAA) Most investors have experienced the highs and lows of financial markets, and probably wished they had the hindsight to buy in during a bear market and sell during a bull market. But of course there is no crystal ball to assist with predicting when markets have peaked or bottomed. market direction is difficult) and while the strategy may result in a gain, the risks are high that the actual timing of buying and selling is wrong. An investor who believes in his ability to buy and sell at the right time is taking a real risk of making errors that could be expensive, and have a negative impact on the investment return. Long term investment focus versus short term trading The annual real returns of Australian equities and bonds over the last 20 years shows the difficulty in choosing the right time to move in and out of asset classes. A 70/30 portfolio 2 with a 70 per cent weight in Australian equities and 30 per cent weight in Australian bonds over the past 20 years has reduced the volatility of returns and provided an annual positive real return in 16 out of the 20 years, compared to 13 out 20 years for a portfolio 100% invested in Australian equities and 4 out 20 years for a portfolio 100% invested in Australian bonds (see figure 1). SAA is the mix of assets of an investment portfolio aimed to meet its long-term objectives. TAA involves adjusting a portfolio s SAA based on market forecasts (usually short term forecasts). The objective is to systematically exploit inefficiencies in the market and adjust market weightings among different asset classes 1. The success of TAA can be inconsistent and akin to an active management approach. It involves a certain amount of guesstimates (forecasting The returns for an asset class maybe higher in isolation but the decision to move into or out of that asset class is unlikely to be timed correctly. By maintaining a SAA over 1 Stockton, K, A. Shtekhman, October 2010, A primer on tactical asset allocation strategy evaluation, Vanguard Group 2 The choice of 70/30 portfolio is for comparative purposes only Figure 1 Annual Real Returns for Australian equities, Australian bonds and a 70/30 portfolio 35% ASX 300 Total Return UBS Composite Bond Index Total Return 70/30 Source: Factset data as at 31 ust 2012 Note: For Australian equities we have used S&P ASX 300 total return index and Australian Bonds, UBS Composite Bond Index total return index 4 Connect with Vanguard > vanguard.com.au >

5 the longer term you may be more likely to a less volatile investment return. Benefits of low costs the impact of compounding In addition to maintaining a strategic asset allocation, lowering your investment costs by investing in a low cost fund such as an ETF or index funds can increase your opportunity for good performance because costs compound over time to eat into your returns. The benefits of lower management fees in long term investments can be seen in figure 2. This chart shows $100,000 invested in 1992 in two Australian shares funds which resulted in a return of $318,736 for a fund with a management cost of 0.75% per annum compared to $ for a fund with a management fee of 1.58% per annum showing savings of over $48,000 for the lower cost fund. This calculation assumes 100% of distributions being reinvested with no capital withdrawals. The management fees are based on the higher fee being the average fee for actively managed retail Australian shares funds and the lower fee based on the retail Vanguard Index Australian Shares fund. Rather than trying to time the market, investors might be better served approaching their investment with some simple and time tested strategies. Maintain a long-term investment focus, keep a keen eye on costs and rebalance your portfolio regularly to bring it back in line with your appropriate longterm strategic asset allocation. Figure 2 Real return after costs over 20 years of the same portfolio with different management costs $400, , ,000 A low cost fund has a higher long term return 250, , , ,000 50, Source: Vanguard Investment Strategy Group based on Morningstar Direct and S&P data dated ust

6 Editor s letter By Robin Bowerman Principal, Head of Corporate Affairs & Market Development The investment industry thrives on complexity. At Vanguard while we accept there are complex challenges in today s world we have a strong belief in keeping things as simple as possible and focusing on getting the basics right. As investors there is one overarching objective we all share: how do we set ourselves up to have the best possible chance of investing success. At Vanguard we believe there are four fundamental principles that can help investors be successful at overcoming the inevitable headwinds we all have to contend with. These are: Create clear, appropriate investment goals This is your declaration - preferably written - of both objectives and any constraints. Objectives are fairly straightforward - the amount you are targeting in superannuation for when you retire; asset preservation and a statement of risk tolerance. It should also include constraints such as the current portfolio value and/or your ability to contribute extra per year and a clear statement of things you want to exclude from the portfolio. Develop a suitable asset allocation using broadly diversified funds If you accept the extensive amount of research that shows the power of asset allocation to impact both the performance and volatility of your portfolio then this is a critical part of any investment plan. It is not just about setting reasonable expectations for returns - it is also about managing risk. Minimise costs Future performance is as uncertain as markets are unpredictable. But costs are forever - although the good news is that unlike markets the costs you pay are controllable. Minimising costs is critical to achieving long-term investment results. Contrary to the typical economic relationship between price and value, higher costs do not necessarily lead to higher returns. Maintain perspective and long-term discipline As human beings we are not particularly well-programmed for investing. Emotions can be a powerful influence and significantly alter a portfolio. The key challenge here is to adopt a systematic approach and then be disciplined and stick to it. It is worth remembering that reasonable contribution levels or spending rates can be more important than investment performance over the long-term. 6 Connect with Vanguard > vanguard.com.au >

7 Helm - October 2012 Your Say By Luke Williams Manager, Client Services Should I invest in Australian Real Estate Investment Trusts (A-REITs)? Many clients are attracted to the tax-effective income yield and potential for capital growth in A-REITs, however investors need to be aware of this sector s risk and return characteristics. REITs are pooled investments which own a portfolio of properties in one or more property sectors. The S&P/ASX 300 A-REIT Index provides the broadest coverage of property trusts listed on the Australian share market. It currently includes securities across the retail, diversified, office and industrial property sectors. Returns from listed property can include income in the form of dividends from the underlying properties and capital growth (or loss) from changes in the value of the share price. Listed property trusts also offer tax advantages to investors in the form of tax deferred income distributions. Tax deferred income, which generally arises from capital allowances and depreciation, is not assessable in your tax return for the year. However, the amount received reduces the cost base. In other words the tax on this income is deferred indefinitely, but is assessable as part of the capital gain if you eventually sell the investment. REIT prices can rise and fall in value due to swings in investor confidence and are subject to factors such as tenancy demand, interest rates and property valuations. In the last decade, the REIT sector underwent considerable structural change as the focus moved towards development, funds management and leverage opportunities. This had the effect of increasing the sector s volatility level and risk profile. The sector has since realigned itself to its traditional long-term risk and return characteristics, which has restored its diversification benefits. Some investors may have existing investments in property trusts if they hold an Australian shares fund. At the end of ust 2012, the weighting of the property sector in the S&P/ASX 300 was 6.8%. Although a higher weighting to the property sector may be entirely appropriate as part of a long-term investment strategy, clients should be aware of the sector risk that arises from being overweight to any one sector compared to the broader market. The global financial crisis (GFC) had a major impact on financial markets and A-REITs were particularly affected. However, over the last 12 months, A-REITs have been one of the best performing asset classes. Whilst past performance should not influence your investment decisions, this does emphasise the importance of staying the course and having an appropriate asset allocation for your financial needs Vanguard Index Chart now available No one can predict the future, which is why making investment decisions based on short-term performance, or the return of just one year, can be a risky strategy compared to a diversified long-term approach. Having a portfolio that is invested across a range of asset classes, sectors and securities ensures investors are well positioned to capture broad market growth, while helping to moderate return volatility over time. At Vanguard, we believe in taking a long-term view, and this year s index chart provides a useful context for looking at how markets have performed over the past 30 years. We hope you find it valuable. You can download or order a copy of Vanguard s 2012 Index Chart by visiting our website at Vanguard wins Fund Manager of the Year 2012 Vanguard is delighted to have been named the 2012 Fund Manager of the Year by Financial Review Smart Investor magazine. The Financial Review Smart Investor Blue Ribbon Awards acknowledge the leading products and services in the fields of investment, finance, banking and insurance. Winners are chosen by Financial Review Smart Investor in conjunction with research houses InfoChoice, Morningstar, Lonsec and Rice Warner Actuaries. To be eligible for the Fund Manager of the Year category, Financial Review Smart Investor takes a fund universe above $5 million in size and filters it using Morningstar ratings of investment grade or above. It then makes a qualitative assessment of fund managers people and processes and their short, medium, and longer-term track records (incorporating both return and risk) relative to competitors, to identify the premier choices in the Australian funds management industry. Vanguard s range of funds performed strongly across the categories. In addition to the overall award, Vanguard was nominated in four other categories, and won the Multi-Sector Balanced category award for the Vanguard LifeStrategy Balanced Fund and the Global/Australian bonds for the Vanguard Index Diversified Bond Fund. 7

8 Connect with Vanguard The indexing specialist > vanguard.com.au > General advice warning Vanguard Investments Australia Ltd (ABN / AFS Licence ) is the product issuer. We have not taken your circumstances into account when preparing this publication so it may not be applicable to your circumstances. You should consider your circumstances and our Product Disclosure Statement ( PDS ) before making any investment decision. You can access our PDS at vanguard.com.au or by calling Past performance is not an indication of future performance. This publication was prepared in good faith and we accept no liability for any errors or omissions. Morningstar data. Vanguard pays a subscription fee for this data. Morningstar All rights reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied, adapted or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. Past financial performance is no guarantee of future results Vanguard Investments Australia Ltd. All rights reserved. HELM 1012